ELITE ADVISOR BEST PRACTICES

Ten Factors to Help Clients Decide Between Buying and Leasing a Business Vehicle - Part One

Most clients understand the basics, but you need to walk them through the specifics.

By Glenn Demby

Key Takeaways:

  • There are two ways to finance a new business vehicle: buying and leasing.
  • Neither method is inherently smarter or better—for some of your clients leasing will make more sense, and for others buying will be the way to go.
  • As a financial advisor, your mission is to show clients the factors to weigh so they make the right decision for their own businesses.


How many times have you been asked by clients to help them make the right buy-versus-lease decision? Turns out there is no perfect answer to the question, but here’s how to help your clients make sound decisions about how to finance vehicles for their small business.

Ten lease-versus-buy factors for your clients to consider

The key to making the right decision is to recognize and properly weigh the advantages and disadvantages of each option and how those pros and cons apply to your client’s situation. Here are the 10 factors your clients need to consider.

Your clients probably understand the general difference between buying a business vehicle and leasing one. But you need to point them to the specifics.

Factor 1: What they get for their money

Buy: Buying brings full ownership without restrictions on how the vehicle can be used and how far it can be driven.

Lease: When leasing, clients pay only the portion of the vehicle’s decline in value that’s expected to accrue during the life of the lease—typically three to five years.

Weighing the options: The above is the conventional wisdom. Let clients know that leasing can result in ownership and that they may be able to exercise the buyout at the end of the lease for less money than they’d have spent to buy the vehicle.

EXAMPLE

ABC Trucks “sells” identical pickup trucks retailing for $30,000 to different customers:

  • Wanda Newford buys one of the trucks for $30,000.
  • Lee Speier leases the other for four years with an option to purchase for $9,000 at lease end.

ABC believes the truck’s fair market value will be $13,000 at the end of the lease. So ABC bases lease payments on $17,000 ($30,000 - $17,000). It turns out that the truck is actually worth $17,000 at lease end. Lee exercises the option.

Result:
  • Wanda paid $30,000 to buy the truck.
  • Lee paid $26,000 ($17,000 lease payments + $9,000 option) to acquire the vehicle.
Factor 2: What they pay up front

Buy: When buying a vehicle, clients must come up with a chunk of up-front cash, including a down payment (or full cash price) and:

  • Sales and other taxes
  • Other government or lender charges
  • Optional insurance and services
  • First monthly payment (if financing the vehicle)

Lease: Clients pay less cash up-front when they lease, including costs for:

  • Capitalized cost reductions
  • Taxes
  • Other government or lessor charges
  • Optional insurance and services
  • First monthly payment
  • Refundable security deposit

Weighing the options: Leasing is better for clients who have cash flow problems or better uses for their cash (e.g., the opportunity to use the cash for investments with a higher return). Of course, the cash trade-off isn’t always black and white. Thus, clients might benefit by simply making a larger down payment on the lease to get a lower monthly lease payment.

Factor 3: What they pay per month

Buy: Monthly payments are higher on purchases because clients pay the entire purchase price of the vehicle plus sales taxes, interest, other finance charges, license fees, personal property and maybe other taxes.

Lease: Monthly lease payments are lower because clients pay for only the depreciation of the vehicle over the lease term plus rent charges and taxes.

Weighing the options: Because lease payments are lower than monthly purchase payments, clients can afford a more expensive vehicle by leasing it. In other words, the same $400 per month that gets clients a Chevy if they purchase might be enough to lease a Cadillac.

Factor 4: What they pay in non-tax depreciation

Non-tax depreciation (i.e., erosion of the vehicle’s fair market value during the time it’s used) is a cost of both buying and leasing. Further, the non-tax depreciation makes its way into your clients’ taxes in the form of deductions and/or loss on sale (if they own the vehicle).

Buy: The decline in value from the time of purchase to the time of sale is a cost that adds or subtracts from your clients’ pocketbooks. But clients might overlook non-tax depreciation and residual value when they buy a vehicle.

Lease: A lease is essentially a bet between your client and the lessor on non-tax depreciation and its effect on the purchase price option at the end of the lease. In this “closed-end lease,” clients know up front how much they can buy the vehicle for at the end of the lease (as opposed to an “open-ended lease,” where they don’t know the actual residual value until they turn in the vehicle).

Weighing the options: Be sure clients recognize that they’re making a residual value bet either way. When they lease, they bet against the lessor. When they buy, they bet against themselves. They’re taking the risk that the vehicle’s value will depreciate more than expected, leaving them owing more on the loan than the vehicle is worth. Leases don’t leave clients “upside down,” because the lessor assumes the risk of unexpected depreciation.

Factor 5: The tax deductions they get

Whether they buy or lease, clients are generally allowed to deduct the business costs of the vehicle using either IRS standard mileage rate for the tax year or their actual expenses.

Caveat: Warn clients that they can’t use the IRS standard mileage rates and must rely on actual costs if their corporation owns or leases the vehicle.

Conclusion

The question of whether to lease or buy business vehicles has bedeviled small-business owners (and their advisors) for years. Neither method is inherently superior to the other. To make the smart decision, each client has to consider his or her particular circumstances, including cash flow, taxes and psychological needs. Savvy advisors should walk their clients through the pros and cons of each approach to help them make a confident decision without buyer’s (or leaser’s) remorse. In part 2 of this article, we’ll look at what happens when clients get rid of the vehicle, what they pay for excess mileage and wear, how much flexibility they need, and other personal considerations.

This article was adapted with permission from MurrayBradfordTaxInstitute.com, a site dedicated to helping self-employed taxpayers and one-owner businesses save on taxes.


About the Author

Glenn Demby is an attorney and prize-winning B2B journalist who specializes in explaining the law in plain English and providing how-to solutions to help business professionals overcome their compliance challenges. He can be reached at 203-354-4532 and at glennsdemby@gmail.com.